Chapter 14: Money, Banks, and the Federal Reserve System (print out graphs and t balance sheets for this section)

Bank Run

a situation in which many depositors simultaneously decide to withdraw money from a bank

2. Unit of Account

a way of measuring value in the economy in terms of money. this makes good have a price in terms of dollars ex. 1 cow = 2 plows

Asset

anything of value owned by a person or a firm

Money

assets that people are generally willing to accept in exchange for goods and services or for payment of debts

how to calculate a change in checking account deposits

change in checking account deposits=change in bank reserves (X) 1/RR

Reserves

deposits that the bank has retained rather than loaned out or invested; deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve. this is usually 10 percent

Fiat Money

money, such as paper currency, that is authorized by a central bank or governmental body that does not have to be exchanged by the central bank for gold or some other commodity money. today no government in the world issues paper current that can be redeemed for gold.

Which category does credit cards fall under?

neither M1 nor M2

Required Reserves

reserves that a bank is legally required to hold, based on its checking account deposit.

Excess Reserves

reserves that banks hold over the legal requirement

what are the key assets on a banks blanche sheet

reserves, loans, and holdings of securities such as US treasury bills

Who manages the money supply?

the Fed (the Federal Reserve)

Federal Open Market Committee (FOMC)

the Federal Reserve committee responsible for open market operations and managing the money supply in the U.S.

3. Store of Value

the ability to hold your money or assets; why do people hold their money? money is the most liquid asset ex. money, stocks and bonds, a house

Monetary Policy

the actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives

Federal Reserve

the central bank of the United States

Simple Deposit Multiplier

the ratio of the amount of deposits created by banks to the amount of new reserves 1/ RR

what did bank panics result in?

they lead to severe disruptions in business activity because households and firms have trouble gaining access to their accounts and may be unable to borrow money

what are the types of loans that banks make

they make commercial loans to firms and consumer loans to households

4. Standard of Deferred Payment

think: layaway and the value of the dollar (the relationship between purchasing power and inflation) when inflation reaches high levels money is mo longer a reliable store of value or standard deferred payment

why are we interested in the money supply

we are interested in the money supply because as we will see changes in the money supply can affect other economic variables, including employment, GDP and inflation

If the money supply grows at a slower rate than real GDP, there will be...

deflation

What is a bank's largest liability?

deposits (checking accounts, savings account, and CDs) Why? because deposits are owed to the households or firms

High rates of inflation and the quantity theory of money

hyperinflation is caused by the central banks increasing the money supply at a rate far in excess of the growth rate of the real GDP

what is the relationship that the quantity theory provides into the long run relationship between thhe money supply and inflation

in the LR inflation results form the money supply growing at a faster rate than REAL GDP

Required Reserve Ratio (RR)

the minimum fraction of deposits banks are required by law to keep as reserves

M1

the narrow definition of the money supply: the sum of currency (paper money and coins) in circulation, checking account deposits in banks, and holdings of traveler's checks

Securitization

the process of transforming loans or other financial assets into securities; a secondary market

what happens when the fed lowers the discount rate

this means that the fed can encourage banks to take additional loans and thereby increase their reserves. with more reserves banks will make more loans to households and firms which will increase checking account deposits and the money supply. raising the discount rate will have the reverse affect

discount policy

when a bank borrows many for the fed by taking out a discount loan the interest rate that the banks pays is called the discount rate.

what happens when the fed reduces the reserve requirements

when they do this it converts RR into excess reserves. this will give banks more money to lend out to consumers. if they raise the RR it has the reverse affect

What are the 5 criteria that make an asset suitable for use as a medium of exchange?

-the asset must be acceptable to most people -it should be of standardized quality so that any two units are identical -it should be durable so that value is not lost but its quickly wearing out -it should be valuable relative to its weight so that amounts large enough to be useful in trade can easily be transported -it should be divisible so that it can be used in purchases of both low-priced and high-priced goods

the three reasons that the fed conducts monetary policy through open market operations

1. because the fed initiates open market operations it compltely controls their volume, which means the fed can carry out both large and small open market operations 2. open market operations are easily reversible. 3. the fed can implement its open market operations quickly with no administrative delay or required charges or regulations.

transformation of the velocity of money formula to understand inflation leads to these conclusions

1. if the money supply grows at a faster rate than Real GDP there will be inflation 2. if the money supply grows at a slow rate than real GDP there will be deflation 3. if the money supply grows at the same rate as real GDP the price level will be stable, and there will be neither inflation or deflation

Why do we need money?

It makes exchange easier; money allows people to specialize and become more productive

Consumer Loans

Loans to households

Quantity Equation

M x V = P x Y M= money supply V= velocity of money P= price level Y= real output (GDP)

Bank Panic

a situation in which many banks experience runs at the same time

How do you calculate stockholders equity/net worth/capital?

Total value of assets - total value of liabilities

velocity of money formula

V=P x Y/M

Fractional Reserve Banking System

a banking system in which banks keep less than 100 percent of deposits as reserves ex. when you deposit $100 in the banks, most of that money will go to someone else due to this idea of a fractional reserve banking system

M2

a broader definition of the money supply: it includes M1 plus savings account deposits, small denomination time deposits (CDs) , balances in money market deposit accounts in banks,and non-instiutional money market fund shares

Lender of Last Resort

a central bank can help stop a bank panic by making loans to banks that cannot borrow funds elsewhere, the bank then can use these funds to pay off depositors, and once the panic ends the banks return the money to the central bank

Security

a financial asset-- such as a stock or a bond-- that can be bought and sold in the financial market ex. Coca-Cola Company Stocks (why? because they can be sold on the New York Stock Exchange)

Commodity Money

a good used as money that also has value independent of its use as money

Barter Economy

economies where goods and services are traded directly for other goods and services *double coincidence of wants is a requirement

who holds cash outside the US?

foreign banks and governments hold some US currency, but mrs is held by households and firms in countries where there is not much confidence in the local currency to where the underground economy is large

deposit insurance

greatly reduced bank runs because ut gas measured all but the largest depositors that the depositors are safe even if the bank goes out of business

Why does fiat money work in our economy?

households and firms have confidence that if they accept paper dollars in exchange for goods and services, the dollars will not lose much value during the time they hold them

If the money supply grows at a faster rate than real GDP, there will be...

inflation

transformation of the velocity of money formula to understand inflation

inflation rate=growth rate of the money supply- growth rate of real output

Why does commodity money not work?

its value depends on purity. therefore someone who wanted to cheat could mix a low value metal, like rom with a precious metal like gold or silver. using gold as money also made the money supply very difficult to control because it depended on partly on unpredictable discoveries of new gold fields

Discount Loans

loans the Federal Reserve makes to banks

Commercial Loans

loans to firms

How do we measure the money supply?

monetary aggregates: M1 and M2

How did the Fed respond to the 2007-2009 financial crisis?

1. in the fall of 2008 under TARP, the fed and treasury began to restabilize the commercial banking system by providing funds to banks in exchange for stock. taking partial ownership of private commerical banks was an unprecedented move by the federal movement 2. the fed modified its dissect policy by setting up several new lending facilities. these lending facilities made it possible for the fed to grant discount loans to financial firms-such as investment banks- that had not previsosult been eligible.

What are the 4 functions of money?

1. it must act as a medium of exchange 2. it must serve as a unit of account 3. it must serve as a store of value 4. it must offer a standard of deferred payment

What 3 tools does the Fed use to manage the money supply aka monetary policy tools?

1. open market operations 2. discount policy 3. reserve requirements

two key points to keep in mind about the money supply

1. the narrowest defention of the moment supply consists of bot currency snd checking account deposits. 2. because balances in checking account deposits are included in the money supply, banks play an important role in the way that the money supply increase and decreases.

What are 2 assumptions we can make about deposit multipliers?

1. when banks gain reserves, they make new loans, and the money supply expands 2. when banks loan reserves, they reduce their loans, and the money supply contracts

Quantity Theory of Money

a theory about the connection between money and prices that assumes that the velocity of money is constant (relationship of the changes in money supply and changes in the price level aka inflation)

which are used to make payments? currency or checking account deposits?

checking account deposits are used more often than currency to make payments. 80 percent of expenditures are made with checks rather than with currency

1. Medium of Exchange

sellers are willing to accept it in exchange for goods/services. this makes the economy more efficient when people accept a single good as a medium of exchange

Discount Rate

the interest rate the Federal Reserve charges on discount loans-when a bank receives a loan from the fed its reserves increase by the amount of the loan

how does the fed decrease the money supply

the FOMC directs the trading desk to carry out an open market sale by selling treasury securities. hen the buyers of the treasury securities pay for them with checks the banking systems reserves fall. this decrease in reserves states a contraction of lans and checking account deposits that reduces the money supply.

Velocity of Money

the average number of times each dollar in the money supply is used to purchase goods and services included in GDP

Open Market Operations

the buying and selling of Treasury securities (maturities of 1 year) by the Federal Reserve in order to control the money supply -to increase the money supply, the FOMC directs the trading desk located at the Fed reserve bank of NY to carry out an open market purchase by buying US treasury securities-most frequently bills, but sometimes notes or bonds- from banks. the fed pays for the treasury bills by depositing the funds in the reserve account bags maintain with the fed.

Liquidity

the ease with which people can convert an asset into the medium of exchange money is the most liquid